notify each dealer, and notify them if their bid has been accepted or not.If the FED analysts estimate that reserve shortages or excesses are expected to remain for a long period of time, the trading desk will make outright purchases or sales of securities. This has a long-term effect on reserve balances.In contrast, if the FED analysts estimate the shortage or excess will be short-term in nature, they use temporary operations. These temporary transactions can be of two types. In a repurchase agreement (repo), the FED purchases securities with an agreement that the seller will repurchase them in the near future, anywhere from 1 to 15 days. This has the effect of adding to reserves temporarily. In a match sale-purchase transaction (reverse repo), the FED sells securities and the buyer agrees to sell them back at some future point in time. The effect of this transaction drains reserves temporarily.When the FED buys securities from the market, reserves are increased, causing the price of reserves (Federal funds rate) to fall. Conversely, when the FED sells securities to the market, reserves are depleted, causing the Federal funds rate to increase.Now that we understand how changes in reserve balances affect the price of reserves, or the Federal funds rate, we can discuss how the FED controls reserve balances to maintain the required Federal funds rate within a specified range. Since reserves are actively traded between banks, the FED must monitor the rates being used for those trades. When the FED sets the target Federal funds rate, they allow for a minimum and maximum level, or ceiling and floor rates. Let us assume the Federal funds target rate is 3.5%. As bank trading of reserves reaches 3.65%, the ceiling requirement, the FED will seek to temporarily increase reserves, buy securities from the market, in order to drive down the Federal funds rate back to the targeted level. Similarly, if reserves trading reaches 3.35%, the f...
